INVENTORY PLANNING

NAZMUN NAHAR

2-1

INVENTORY

Inventory: a stock or store of goods

Independent Demand

Dependent Demand

C(2)

B(4)

D(2)

E(1)

D(3)

F(2)

Independent demand is uncertain.

Dependent demand is certain.
12-2

INVENTORY MODELS
Independent demand finished goods,

items that are ready to be sold

E.g. a computer

Dependent demand components of

finished products
E.g. parts that make up the computer

12-3

Economic Order Quantity

(EOQ) Models
EOQ
optimal order quantity that will

minimize total inventory costs

Basic EOQ model
Production quantity model
Quantity discount model

12-4

Assumptions of Basic EOQ

Model
Demand is known with certainty and is constant
over time
No shortages are allowed
Lead time for the receipt of orders is constant
Order quantity is received all at once

12-5

Copyright 2006 John Wiley & Sons,

Inc.

ECONOMIC ORDER QUANTITY

(EOQ) MODEL

Holding costs
are linearly
related to
order size

Annual Cost

Q
Annual Holding 2 H
Cost =

Where,
Q = Order quantity in units
H = Holding (or carrying) cost
per unit
Q
2

Order Quantity (Q)

ECONOMIC ORDER QUANTITY

(EOQ) MODEL (CONTD.)

Ordering costs
are inversely
and nonlinearly
related to order
size

Annual Cost

D
Annual Ordering Q S
Cost =

Where,
Q = Order quantity in units
D = Demand, in units per
year
S = Ordering cost

D
Q

Order Quantity (Q)

ECONOMIC ORDER QUANTITY

(EOQ) MODEL (CONTD.)
holding + Annual
Total costAnnual
=
cost Q
ordering cost
D S
TC =
H
+
Q
2

Annual Cost

TC
Holding Costs

Ordering Costs
QO (optimal order quantity)

Order Quantity (Q)

DERIVING THE EOQ

TC =

Q OPT =

Q
2 H

D S
Q

2DS
2(Annual Demand)(Order or Setup Cost)
=
H
Annual Holding Cost
The total cost curve reaches its
minimum where the carrying
and ordering costs are equal.

EOQ Example
H = $0.75 per yard

S= $150

D = 10,000 yards

What is EOQ and Minimum Total cost

What is optimum number of orders per year
What is order cycle time

Production Quantity
Model
An inventory system in which an order is

received gradually, as inventory is

simultaneously being depleted
assumption that Q is received all at once is
relaxed
p - production rate
d - daily rate at which inventory is
demanded

12-11

Production Quantity Model

(cont.)
p = production rate

d = demand rate

Maximum inventory level = Q - Q d

p
= Q1- d
p
Average inventory level =
SD
TC = Q

Q
d
12
p

HQ
d
+ 2 1p
12-12

2DS
Qopt =

d
H 1p

Production Quantity Model

(cont.)
Inventory
level

Q(1-d/p)

Maximum
inventory
level

Q
(1-d/p)
2

Average
inventory
level

0
Order
receipt period

Begin
End
order
order
receipt receipt
12-13

Time

Production Quantity Model:

Example
H = $0.75 per yard
S = $150
d = 10,000/311 =32.2 yards per day

12-14

D = 10,000 yards
p = 150 yards per day

Quantity Discount Model

A quantity discount is simply a reduced price

(P) for an item when it is purchased in LARGER

quantities.
A typical quantity discount schedule is as
follows:

Example
Consider the quantity discount schedule given

in the beginning (above).

Assume that the Ordering (Setup) Cost (S) is
$49 per each order.
Annual Demand (D) is 5000 units, and
Inventory carrying charge is a percentage
(I=0.20) of product cost (P).

Example

Example
- For Q2, allowable range is 1000-1999. Since
Q2* = 714 is not in the allowed range, we
adjust it to the lowest allowable value, That is
Q2* = 1000.
- For Q3, allowable range is 2000-. Since Q3* =
718 is not in the allowed range, we adjust it to
the lowest allowable value, That is Q3* =
2000.

Example

Practice 1
You order a product that has a price break

offered:
Order less than 1000
$4.03 / unit
Order 1000 to less than 2000 $4.00 / unit
Order 2000 or more
$3.97 / unit

Your annual holding cost rate is 10%

Your cost per order is $5.00
Your annual requirement is 5,000 units.

Practice 2
You order a high-demand software package

that has a price break offered:

Order less than 5
$169.00 / unit
Order 5 to less than 50 5% discount / unit
Order 50 to less than 100
8% discount / unit
Order 100 or more

10% discount / unit

Your annual holding cost rate is 30%

Your cost per order is $ 5.00
Your annual requirement is 2,500 units.

INVENTORY CYCLE
Q
Quantity
on hand

Profile of Inventory Level Over Time

Usage
rate

Reorder
point

Receive
order

Place Receive
order order
Lead time

Place Receive
order order

Time

Reorder Point
Quantity to which inventory is allowed to

drop before replenishment order is made

Need to order EOQ at the Reorder Point:
ROP = D X LT
D = Demand rate per period
LT = lead time in periods

REPLENISHMENT SYSTEM
Cost of replenishment is the expenses associated with buying

things.
If

you buy smaller quantities more often, your

purchasing costs go up - or your R Factor increases.

If you buy larger quantities less often, you have a

higher inventory level for a longer period of time, so

your carrying costs go up - or your K Factor increases.
In a perfect world the K Factor and the R Factor would be equal.

Although this is difficult to achieve, an organization attempting to

have the correct amount of product at the overall lowest cost will
strive for that balance. Inventory - Stock simply sitting around
does no one any good.

MIN - MAX INVENTORY SYSTEM

By setting a min-max for each item in our inventory, we can create

a simple method of ordering products having independent demand.

A two-bin system with Bin 1 contains working stock and Bin 2

contains working reserve.

In a two-bin system, if all goes as it should, then immediately

upon using the first item from Bin 2, you would reorder a quantity
equal to both Bins 1 and 2. As you use the last item in Bin 2, the
order arrives and you refill both bins. This assumes that lead time
is exact, there are no vendor stock outs or backorders, and that
there are never any defects. That assumption is, of course, often
false. Therefore, a true order-point system is a three-bin system,
with the Bin 3 containing safety stock.
Bin 3, safety stock, relates to Bin 2 since Bin 3 is to make up for

uncertainties in lead time and defects. Mathematically safety stock

is 50 percent of working reserve.

REORDER POINT

MAXIMUM LEVEL
In order to compute the maximum in these systems, we must

first determine how often we will place orders. This time period
is called the review cycle.
The review cycle is the length of time between reviews of when

we wish to order product. The formula to determine the review

cycle is:

REORDER POINT (MATH)

A company orders 2,00,000 units from a vendor. The

minimum quantity for discount is 5000 units. They use

raw material at a usage rate of 1200 units per month.
The lead time is 3 weeks.
Calculate the weekly usage.
Calculate the working reserve.
Calculate the safety stock.
Calculate the ROP.
Calculate the review cycle and Maximum inventory level.

Do the same math using lead time of 1 week.

Reorder Point: Example

Demand = 10,000 yards/year
Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154 yards/day
Lead time = L = 10 days
R = dL = (32.154)(10) = 321.54 yards

12-29

Copyright 2006 John Wiley & Sons,

Inc.